When I first added up all my debt in 2005, my Bad Debt Ratio was over 86%. Today it is 14.88%, slipping under the recommended maximum of 15% for the first time ever!
What is a Bad Debt Ratio?
This is the ratio of your total unsecured “bad debt” (excluding mortgage debt and student loan debt) to your individual (not household) annual take-home income. For example, if you have a $3,000 auto loan and carry a $5,000 balance on your credit cards, and take home $30,000 per year, then your Bad Debt Ratio is
($3,000+$5,000) / $30,000 = 26%.
The Bad Debt Ratio is similar to the Debt-to-Income Ratio. The difference is that the Debt-to-Income Ratio includes “good debt” such as student loans. For more on the difference between Good Debt and Bad Debt, click here.
What is the significance of 15%?
A Bad Debt Ratio above 15% can have a negative affect on your credit score. The recommended Bad Debt Ratio is under 15 % to help you qualify for the lowest interest rates possible when extending your credit to buy a home or car.
How did we accomplish this?
On our reader’s advice, we used about $7,000 of our savings to pay off credit card debt this month. Ouch! We still have about $4,500 of credit card debt remaining, but that’s all one one card with a lifetime 0% interest rate. We will pay that off this year…the end is in sight!